On Beijing expectations and speculation

Quick read
Divyang Shah

China is looking to achieve growth of 7.5% this year the same as last year’s target. Anything less than 7.5% would have promoted unwanted debate as to how much economic downside policy makers were willing to accept.

But it would be a mistake to view 7.5% as a floor or a target. Continued job growth and reforms could see a willingness to tolerate growth as low as 7.0%.

Such a reassuring growth target is a useful means of expectations management. The key is to signal that reforms will progress at a pace that does not jeopardise the recovery or jobs.

The tail risk of a hard landing is something that policy makers do not want to build into investor, business or household expectations. As the year and reforms progress, we could see a greater willingness to talk about growth as low as 7.0%.

When it comes to the housing/credit bubble, the risks remain in play and the focus is shifting from tightening money market rates to punishing – and hopefully limiting – speculative inflows on the RMB.

Once CNH and CNH carry traders become discouraged, attention should turn back toward the appropriate distribution of liquidity through both a tightening of money market rates as well as selective defaults on WMPs. Such moves would serve to inject the notion of risk into an equation that has focused solely on return.

An environment of reduced speculative activity and better capital allocation will form the basis of lasting growth.

Previous excesses will be allowed to roll off, and increased FX and money market volatility will be used as a tool to clamp down on new excesses.